Estimating Life—Cycle Parameters from Consumption Behavior at Retirement”

Using pseudo-panel data, we estimate the structural parameters of a life—cycle consumption model with discrete labor supply choice. A focus of our analysis is the abrupt drop in consumption upon retirement for a typical household. The literature sometimes refers to the drop, which in the U.S. Consumer Expenditure Survey we estimate to be approximately 16%, as the “retirement—consumption puzzle.” Although a downward step in consumption at retirement contradicts predictions from life—cycle models with additively separable consumption and leisure, or with continuous work-hour options, a consumption jump is consistent with a setup having nonseparable preferences over consumption and leisure and requiring discrete work choices. This paper specifies a life—cycle model with these latter two elements, and it uses the empirical magnitude of the drop in consumption at retirement to provide an advantageous method of identifying structural parameters–most importantly, the intertemporal elasticity of substitution.